Case 063Performance evaluation and manager selectionCore
An equity fund lagged its benchmark by 1.1 points. Given sector weights and returns for the fund and the benchmark, split the gap into allocation and selection by sector and tell the story.
1The situation
Stambh Equity Fund returned 8.5% last year against 9.6% for its benchmark, a gap of 1.1 points. The board wants to know whether the manager made the wrong sector bets or picked the wrong stocks.
Sector weights and returns for the year, benchmark first and fund second:
Financials: benchmark 35% of the index returning 10.0%, fund 40% returning 5.5%. IT: benchmark 15% of the index returning 14.0%, fund 10% returning 15.0%. Consumer: benchmark 20% of the index returning 8.0%, fund 20% returning 9.0%. Energy: benchmark 15% of the index returning 4.0%, fund 10% returning 5.0%. Industrials: benchmark 15% of the index returning 12.0%, fund 20% returning 12.5%.
2Your task
Split the 1.1 point gap into allocation and selection effects by sector, and give the board a one-paragraph story.
Quick check
Stambh was overweight financials, a sector that beat the benchmark. What did that sector bet do on its own?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Sector allocation added 0.20 points; stock selection cost 1.30, and financials alone cost 1.80. The manager's sector bets were right: underweight energy and IT, overweight industrials. But the financials held returned 5.5% against 10.0% for the sector, on a 40% weight. Stock picks in the other four sectors added 0.50 points. The story is one sector's stock selection, not a broad failure.
Step 1What are allocation and selection, in plain words?
Think of a cricket selector who picks how many batsmen and bowlers to field, and a captain who picks which players. Allocation asks whether the fund put more money in sectors that beat the benchmark as a whole; selection asks whether, inside each sector, the fund's stocks beat that sector. The BrinsonThe Brinson, Hood and Beebower method, 1986, which splits active return into allocation and selection effects by segment. method measures allocation as the weight difference times the sector's return over the benchmark's, and selection as the fund's weight times the fund's return over the sector's.
Step 2What does each sector contribute?
| Sector | Weights, bench / fund | Returns, bench / fund | Allocation | Selection | Total |
|---|---|---|---|---|---|
| Financials | 35% / 40% | 10.0% / 5.5% | +0.02 | -1.80 | -1.78 |
| IT | 15% / 10% | 14.0% / 15.0% | -0.22 | +0.10 | -0.12 |
| Consumer | 20% / 20% | 8.0% / 9.0% | +0.00 | +0.20 | +0.20 |
| Energy | 15% / 10% | 4.0% / 5.0% | +0.28 | +0.10 | +0.38 |
| Industrials | 15% / 20% | 12.0% / 12.5% | +0.12 | +0.10 | +0.22 |
| All sectors | 100% / 100% | 9.60% / 8.50% | +0.20 | -1.30 | -1.10 |
Work one line out loud. Energy: the fund held 10% against 15%, and energy returned 4.0% against a benchmark of 9.6%. Being 5 points underweight a sector that lagged by 5.6 points added 0.05 times 5.6, about 0.28 points, the largest allocation gain. Underweighting IT, the best sector, cost 0.22. Every selection effect outside financials is positive, between 0.10 and 0.20 points.
Step 3What is the story for the board?
One paragraph. The manager's sector calls were sound and added 0.20 points. Stock-picking was good in four sectors out of five. The shortfall comes from financials, where a 40% position, the fund's largest, returned 5.5% while the sector returned 10.0%: that single decision cost 1.80 points. The next question is why. Perhaps the fund avoided the large private banks that led the rally and held smaller lenders or insurers, or held a lender that hit asset quality trouble. That is a conversation about one book of stocks, not about the whole process.
Mention the fine print. With the fund's weight used in selection, the interaction between an overweight and poor picks is folded in: of the 1.80 points lost in financials, 1.575 is pure selection on the benchmark's 35% weight and 0.225 is the extra 5 points of weight in a sector where the picks lagged. And one year of attribution is thin evidence; ask for three.
Where candidates lose it
The common loss is blaming the overweight in financials because financials is where the money was lost. The overweight itself was right; the sector beat the benchmark. The damage is selection, and mixing the two gives the board the wrong fix.
The second is forgetting that allocation compares a sector with the whole benchmark, not with zero. Overweighting a sector that returned a positive 4% can still cost you if the benchmark returned more.
What the interviewer asks next
- How would the attribution change if you used benchmark weights for selection and showed interaction separately?
- The manager says the financials underperformance was a deliberate defensive choice. How would you test that?
- Why can single-period attribution mislead over several years?
- How would you attribute a fund that holds 8% in cash?
Company names and figures are illustrative.